Monday, February 11, 2008

Consumption Equality 7X > Than Income Equality

Dallas Federal Reserve Bank VP/Chief Economist Michael Cox was featured in Drew Carey's video "Living Large: America's Middle Class" (see CD post here).

In today's NY Times, Cox and co-author Richard Alm have an excellent article "You Are What You Spend," which addresses some of the Dobbsian (Lou) myths of "Two Americas," the "Disappearing Middle Class," the "War Against the Middle Class," etc.

According to Cox and Alm, the problem with these myths is that they focus on the wrong measure of financial well-being: Income statistics, which don’t accurately measure Americans’ living standards. "Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume."

For example, "The bottom fifth earned just $9,974, but spent nearly twice that — an average of $18,153 a year. How is that possible? Those lower-income families have access to various sources of spending money that doesn’t fall under taxable income. These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, or the drawing down of bank accounts. While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status."

Consider these statistics comparing the top fifth (richest 20%) and the bottom fifth (poorest 20%), measured by household income (see chart above, click to enlarge):

Household Income Ratio: 15 to 1
($149,963 top 20%, $9,974 bottom 20%)

Household Consumption Ratio: 3.84 to 1
($69,863 top 20%, $18,153 bottom 20%)

Persons Per Household: 1.82 to 1
(3.1 top 20%, 1.7 bottom 20%)

Consumption Per Person: 2.1 to 1
($22,536 top 20%, $10,678 bottom 20%)

Bottom Line: Even though households in the top fifth earn 15 times more income per household than the bottom fifth, those households in the top quintile consume only twice as much per person as the bottom fifth. Or, we could say that income inequality is 7 times greater than consumption inequality, or consumption equality is 7X greater than income equality.

Living standards are determined by consumption, not income, so the obsession about income inequality is a distraction from the fact that consumption, and therefore living standards, are distributed much more evenly than we think. After all, both low-income and high-income households own many of the same conveniences: color TVs, cell phones, microwave ovens, washers, dryers, VCR/DVD players, iPods, computers, etc.

16 Comments:

At 2/11/2008 10:34 AM, Anonymous Anonymous said...

A few days ago Standard and Poor's said that the World stockmarkets lost of 5.2 trillion dollars (3.6 trillion euros) in January what effect if any will that and other negative economic news have on consumption?

My guess that consumers, in general, are reducing or eliminating discretionary spending resulting in reduced spending right now.

When these same consumers "feel" more secure about their economic future are they likely to over consume for a period of time or will a period of frugality lead to lower consumption habits that are hard to break?

 
At 2/11/2008 10:49 AM, Anonymous Machiavelli999 said...

That post reminded me of one of my favorite quotes of all time, by Andy Warhol:

"What's great about this country is that America started the tradition where the richest consumers buy essentially the same things as the poorest. You can be watching TV and see Coca Cola, and you know that the President drinks Coca Cola, Liz Taylor drinks Coca Cola, and just think, you can drink Coca Cola, too. A coke is a coke and no amount of money can get you a better coke than the one the bum on the corner is drinking. All the cokes are the same and all the cokes are good. Liz Taylor knows it, the President knows it, the bum knows it, and you know it."

– The Philosophy of Andy Warhol: (From A to B and Back Again), 1975

The point is Bill Gates might have 10,000x more money than you, but that doesn't mean he enjoys his life 10,000x more. He basically eats the same McDonald's hamburgers that you do, he drinks the same Coca-Cola that you do, he watches the same movies you do.

 
At 2/11/2008 11:31 AM, Anonymous marmico said...

These sources include portions of sales of property like homes and cars and securities that are not subject to capital gains taxes, insurance policies redeemed, or the drawing down of bank accounts.

Sure, Mark. Every low income household in Flint, Michigan, flipped a property for profit, dusted off and sold a Shelby Mustang at the Jackson-Barrett auction, cashed out a life insurance policy and drew down a savings account into overdraft last year. Sure, Mark.

From the Gordon, Dew-Becker paper:

While authors have found parts of the CEX show consumption inequality to be flat, other more believable parts of the CEX show
consumption inequality to rise at roughly the same rate as income inequality
. This evidence is consistent with that of Kopczuk, Saez, and Song (2007) who find that there has been no increase in income mobility associated with the rise in income inequality.

 
At 2/11/2008 12:25 PM, Anonymous bob wright said...

marmico:

Don't forget or ignore the large swath of households that show low AGI and taxable income that are made up of retirees with substantial assets.

There are lots of them.

 
At 2/11/2008 12:58 PM, Anonymous Cranky said...

Where do these consumptuion stats come from? But, from a Forbes article: "The top fifth of American earners get 84% of their income from wages and salaries. But the middle fifth only draw 77% of their money from a job, and the lowest just 38%.

At that bottom end of the scale, retired and unemployed Americans rely far more on safety nets: the lowest-earning fifth of the population gets 48% of its yearly income from retirement funds like Social Security, and 9% from public assistance programs like food stamps. The middle fifth of the population only gets 16% of its income from retirement funds and 0.5% from public assistance, and the richest fifth only 4% and 0.1%, respectively.

Cranky

(can anyone say whether the Exxon taxes - discussed here earlier - were paid entirely into American coffers, or is that paid to various nations?)

 
At 2/11/2008 1:13 PM, Blogger Cranky said...

The Forbes article is called "How Americans Make And Spend Their Money" (2006) by Laurence H. M. Holland and David M. Ewalt and found here http://tinyurl.com/2stlzp

 
At 2/11/2008 1:43 PM, Anonymous marmico said...

Hello Bob, I don't know whether the income curve or the consumption curve is the best measure of deprivation (poverty) in American society. But a fact finding person would certainly consider both measures and cite studies in support of either position. Perry cites the Dallas Fed, so I'll cite the Minneapolis Fed.

 
At 2/11/2008 1:51 PM, Blogger Walt G. said...

The chart shows something that isn’t mentioned, but is important. Obviously, the bottom quintile is spending all of their income (and then some). On the other hand, the upper quintile has money left over after consumption. Accordingly, the upper quintile is able to build wealth and the lower quintile cannot accumulate wealth. Since wealth is an accurate standard of future financial security, the upper quintile is in much better financial shape than the lower quintile. So, if we use wealth as the standard, the rich are getting richer, and the poor are getting poorer.

Of course, this assumes no mobility between the five groups. However, most of what I’ve read shows the majority of the mobility is between the three middle quintiles and not the bottom and the top quintiles.

It would be interesting to know how much of the money spent by the bottom quintile is borrowed. I doubt all of the difference in this group between consumption and income is from selling assets. Just like the government (tax rebates?), some people try to spend themselves out of trouble.

 
At 2/11/2008 2:40 PM, Blogger bobble said...

LOL, that's got to be the funniest thing you ever posted, mark.

please view the following link

http://tinyurl.com/33xawb

 
At 2/11/2008 2:52 PM, Blogger Walt G. said...

Many economists measure a country’s financial health by the GDP and the ratio of the deficit to the GDP.

These same people say that just looking at the yearly numerical deficit is misleading. Isn’t that what this graph is doing?

An individual’s real financial health needs to be measured by net worth and not how much they spend in one year.

 
At 2/11/2008 4:00 PM, Anonymous bob wright said...

Cue theme song to "The Jeffersons".

From the Thomas Sowell column dated January 23, 2008.

You can check out the numbers for yourself in a November 13, 2007 report from the Treasury Department titled "Income Mobility in the United States from 1996 to 2005." You can find a summary of the same data in a Wall Street Journal editorial that same day.

These are not the only data that tell a diametrically opposite story from the usual political and media story that the rich are getting richer and the poor are getting poorer.

A previous Treasury Department study showed similar patterns in individual income changes between 1979 and 1988.

Moreover, a study conducted at the University of Michigan, following the same individuals over an even longer span of time, likewise found most people moving from income bracket to income bracket over time -- especially among those who began in the bottom 20 percent.

The University of Michigan Panel Survey on Income Dynamics showed that, among people who were in the bottom 20 percent income bracket in 1975, only 5 percent were still in that category in 1991. Nearly six times as many of them were now in the top 20 percent in 1991.

 
At 2/11/2008 5:14 PM, Blogger Walt G. said...

I think defining "rich" and 'poor" is the problem.

I wrote a research paper on the term "middle class." My findings were that middle class was a state of mind to people. Middle class simply was not quantifiable. Even government agencies used different criteria in an attempt to define the ambiguous term.

We do live in better times than the past. Probably the best of times. However, measuring success by current consumption masks the fact that many people are ignoring their future by failing to save. Depending on Social Security for the sole source of their retirement income will indeed be life-altering. No amount of looking at the bright side today is going to change that fact. Wealth accumulation (net worth) is a much better indicator of how the population is financially fairing than current income and consumption.

 
At 2/11/2008 5:42 PM, Anonymous bob wright said...

walt g:

This is why I believe social security should be privatized in order to give the poor an automatic, payroll-deduct, means of accumulating wealth that can be passed on.

The account can be put into government bonds - where it is now, presumably.

It would essentially be just like the thrift plan available to government employees today - sans the non government bond investment options.

 
At 2/11/2008 8:00 PM, Anonymous Anonymous said...

Walt g,

As you say, the definitions for rich and poor vary widely and muddy the issue.

It is ironic that in creating a social safety net, one also creates moral hazard yet it is a huge improvement over the privations experienced in the early 20th century.

 
At 9/13/2008 8:23 PM, Anonymous Terry Pratt said...

Households in the bottom income quintile are are diverse and dissimilar to people working at the bottom of the economy (those at or near minimum wage). Under our official government definition of poverty, a retiree living on a modest Social Security retirement benefit in a free-and-clear home can be "poor" while a hamburger flipper earning minimum wage and spending half his income on rent is "not poor" - but who has the higher standard of living?

As one who has worked for decades at or near minimum wage; in most years I am NOT in the bottom quintile, but rather the quintile above it.

Income and poverty statistics are quite distinct from asset or net worth data. I am not in the bottom quintile by income but I am certainly in the bottom quintile of net worth.

 
At 9/13/2008 9:05 PM, Anonymous terry pratt said...

bob wright said:

The University of Michigan Panel Survey on Income Dynamics showed that, among people who were in the bottom 20 percent income bracket in 1975, only 5 percent were still in that category in 1991. Nearly six times as many of them were now in the top 20 percent in 1991.



Um, Bob, about all it takes to "rise" from the bottom quintile to the second quintile is a full-time minimum wage job. So it is easy to rise out of the bottom quintile if you are able-bodied and not retired.

Those in the bottom quintile just starting out in 1975 (maybe they were in college?) rose merely by going to work full time. And if they were in college in 1975, there is a high probability they were on track to earn top-quintile incomes by 1991.

Those in the bottom quintile who were retired in 1975 were largely dead by 1991.

So I find nothing remarkable in the statistics you cite.

 

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